Commentary

No escape from austerity for Club Med countries

Commentary: So far, voters are willing to go along to save the euro

By

BarryWood

WASHINGTON (MarketWatch) — The ball and chain of recession is weighing heavier in the European Union’s southern periphery.

Last week, the International Monetary Fund downgraded its forecasts for Spain, Italy and Greece, predicting that economic activity will weaken in 2013 with all three countries expected to register another year of negative growth.

Italy and Spain — the third and fourth biggest economies in the euro zone — are projected to record 1% to 1.5% economic declines. Greece, in its sixth year of depression, is projected to decline by over 4%, an improvement from the 6% contraction in 2012.

Reuters

In the latest test of the willingness of the people to endure austerity in order to keep the euro alive, Italian Prime Minister Mario Monti will face the voters in about a month.

While there are variations within the 17-nation euro zone, overall Europe’s great recession is deeper than anything experienced in the United States.

Take the auto sector, for example. European car sales in 2012 were down for the fifth consecutive year. In the States, by contrast, car sales declined only two years — 2008 and 2009, before beginning a steady recovery. In Europe there are no signs of recovery.

In Europe’s southern periphery the decline is, of course, deeper.

Car sales in Italy were down 20% in 2012 to the lowest level since 1979. No wonder Sergio Marchionne prefers to spend his time in Detroit with Chrysler instead of at Fiat
IT:FI
headquarters in Turin. Marchionne says the European car industry probably lost €5 billion last year.

Sadly for countries in a fixed-currency system that have been shut out of bond markets, policy makers have few options but to tighten fiscal discipline and boost competitiveness while waiting for recovery in the European core. Jacob Kirkegaard of Washington’s Peterson Institute for International Economics describes the euro zone as a prison, a Hotel California, where you can come in but never leave. In fact, countries can leave the euro zone but neither citizens nor governing elites have made that choice.

Within the past 24 months, voters in Club Med countries have signaled their willingness to endure austerity if that is the price for remaining within the euro zone. Portuguese voters in January 2011 elected a government committed to the euro and fiscal rigor. Spanish voters made a similar choice in November 2011 and even in Greece the government that emerged from the second of two elections in 2012 significantly accelerated the austerity measures that were only tentatively implemented by its predecessor.

Now the big test is Italy, which holds its parliamentary election on Feb. 24. Technocratic leader Mario Monti, who pursued a pro-euro reform agenda in 2012, is on the defensive and the result is anyone’s guess.

While not as hard hit as neighboring Greece, Italian living standards have taken a huge hit from the crisis. Personal income is down, poverty is up, youth unemployment has reached 37% (12% overall), taxes on property and incomes are up, money is fleeing Italian banks, and home prices are falling. Former Prime Minister Silvio Berlusconi has mounted a political comeback and he has spoken of pulling Italy out of the euro.

In the Jan. 23 revision to its economic outlook, the IMF says uncertainty in euro zone remains the biggest risk to the global recovery. It warns of “prolonged stagnation in the euro area as a whole ... if the momentum for reform is not maintained.“ Read more on the IMF’s views on the economy, currency wars.

In effect, the IMF is saying that if the euro is to survive, imbalances within the zone must be remedied and there is no alternative to austerity to improve competitiveness in the peripheral countries.

Up until now the biggest threat to the euro has come from Greece but in recent months Athens has left no doubt of its willingness to take bold measures to restore fiscal balance.

Few analysts thought this possible. Most predicted social unrest and a collapse of the coalition government with perhaps radical leftists advocating a euro exit coming to power. Instead Greece has been slashing public-sector jobs, stepping up privatization, and cutting social benefits to narrow the budget deficit.

Reuters

Anti-austerity protesters gather at the Spanish Parliament in September 2012.

Greece is the recipient of the biggest loan ever approved by the IMF and even larger resources are coming from European Union countries. They have provided an unprecedented level of assistance, resources equal to more than half of Greece’s gross domestic product. Surprisingly, the lenders say the austerity that hurt the poorest has cut deep enough. They are insisting that the government go after wealthy individuals and companies that don’t pay taxes, often shielding their assets outside the country.

Miranda Xafa of EF Consulting in Athens is mildly optimistic. She says Greece could even emerge from recession next year if it implements structural reforms that “open up the closed professions, reduce red tape, and liberalize the energy and transport sectors to reduce the cost of services.” Despite hardship, opinion surveys suggest that 65% to 70% of Greeks wish to remain in the euro zone.

Uncertainties, of course, abound. Civil unrest could force a slowing of adjustment in any of the stricken economies — Greece, Italy, Spain, or Portugal. Aside from Greece, risks may be greatest in Spain where unemployment among young people has reached a shocking 55% and the overall jobless figure approaches 25%.

For now, the euro crisis is quiescent as the declaration in August by European Central Bank chief Mario Draghi that he would do “all that is needed” to preserve the euro has driven down bond yields in the periphery countries.

The optimistic scenario is that 2013 is a transition year, that the reforms are working and that the recovery currently gathering strength in the U.S. and Asia will bolster Europe, leading to resumed growth in 2014.

Barry D. Wood is a columnist and North American economics correspondent for RTHK in Hong Kong.

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